If you're in your 20s or 30s, retirement probably seems like a faraway dream. However, if you make the right financial moves early on in your career, you can make early retirement a real possibility. Here are some of the most important steps you can take to move your retirement date forward by several years.
Set your retirement goal
The more specific your goal is, the more likely you are to reach it. So when planning for retirement, don't just set a hazy goal like "retire early." Make it specific by picking the exact age at which you want to retire.
Assuming you want to retire on the early side, 59 1/2 may be the earliest you could expect to do it: That's the age at which you can start taking withdrawals from tax-advantaged retirement savings accounts, including 401(k)s and IRAs, without getting hit with an early withdrawal penalty. Another reasonable early retirement age is 62, when you can first claim Social Security retirement benefits. But feel free to pick any age for your retirement goal -- as long as you have the savings plan to back it up.
Start retirement contributions today
Early contributions are a lot more valuable than late contributions, because they have more time to generate returns and build up your balances by the time retirement rolls around. When you tuck money into a retirement savings account, your returns will compound over time. Briefly, that means that you'll not only get returns on the money you save, you'll also get returns on your returns. If you put $1,000 into a portfolio earning 5% per year, then the first year you'll earn $50, bringing your total in the account to $1,050. Leave that money in the account, and the following year you'll get paid 5% of $1,050 rather than $1,000. As your balance grows from year to year, so do the annual returns.
For example, let's say you're 25 years old and you have $20,000 invested inside your 401(k). If you get an 8% average annual return on that money, then after 10 years, the balance would have grown to $43,178 -- more than double your initial investment. After 20 years at an 8% return, it would have grown to $93,219. And after 30 years, when you reach age 55, the money would have turned into $201,253 -- more than 10 times the amount you originally saved. As you can see, every penny you contribute today can come back to you tenfold (or more) a few decades later. And that's just what would happen to your initial investment; continuing to make contributions over your working life can get you enormously higher balances by the time you retire.
Put your money in stocks
The other major benefit of saving early is that you can afford to take risks with that money in the pursuit of higher returns. If retirement is still decades away, then your savings will have plenty of time to recover from any dips in the value of your investments.
For retirement savings purposes, stocks are the king of high average long-term returns. In any given year, the stock market can produce either incredibly high or incredibly low returns, but over several decades, the average return for large companies' stocks hovers around 10% per year. And the longer your investment window is, the more likely you are to achieve (or exceed) that average return. You'll probably also have some terrible years in there, but since you're not actually spending your retirement savings money yet, it doesn't matter if your accounts take temporary losses. By all means, put 90% or even 100% of your retirement savings into stocks while you're in your 20s and 30s, and you'll reap significantly higher average returns as a result.
Use a tax-advantaged account
Tax-advantaged retirement savings accounts come in two basic flavors: traditional and Roth. Traditional IRAs and 401(k)s give you a tax deduction on the money you contribute to the account, but after you retire and start taking money out, you'll have to pay income taxes on those withdrawals. Roth IRAs and 401(k)s work the other way around: You don't get an up-front tax break on your contributions, but your distributions during retirement are completely tax-free.
Both types of tax-advantaged retirement accounts have annual contribution limits; in the case of IRAs, the limit is a mere $5,500 per year for 2018, so if you don't have a 401(k), you'll likely need to max out your IRA contribution in order to have a chance at early retirement. Note that the contribution limit includes both Roth and traditional accounts of that type. For example, if you contribute $3,000 to your traditional IRA in 2018, you can't put more than $2,500 in your Roth account that year.
When you start making contributions early, a Roth account may be the best deal tax-wise, because your income is likely to be lower in the early stages of your career than it will be once you retire. That means you'll save more money by postponing the tax break until you're retired and are in a higher tax bracket. However, if you've deliberately planned for a low-cost retirement to help expedite the big day, you may be better off directing the bulk of your contributions to a traditional account. In that scenario, your retirement income may well be lower than your current income, so taking your tax break now can maximize your tax savings.
Buy a house -- and pay it off
Housing is typically the single biggest monthly cost we pay. If you can get rid of that expense during retirement, then you won't need nearly as much income to live comfortably after you retire -- which means you'll have a much easier time saving enough money in time for early retirement.
For example, say you crunch a few retirement expense numbers and decide that you'll need $40,000 a year from your investments to finance your retirement -- a figure that includes $1,500 a month in housing payments. To generate that much income, you'll need to have at least $1 million saved by retirement, assuming you follow the 4% rule. But if you can get rid of your housing payment by paying off your mortgage before you retire, you'll only need $22,000 per year in retirement income, which means you'll need a minimum balance of just $550,000 by retirement -- a far easier goal to accomplish.
Another option for cutting your retirement costs is to retire to an area with an extremely low cost of living, which can permit you to live comfortably on even a tiny income. Owning your own home beforehand is still an excellent idea, because selling that house can provide you with plenty of cash to finance your move and buy a new, cheaper house in your desired location. With luck, you'll even have some money left over to keep for emergencies.
Retiring early will likely take some serious planning and a few sacrifices along the way, but the earlier you start working on it, the easier it will be. Isn't it worth setting aside a little extra money instead of spending it today?
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